States Ponder: What Happens When the Money Stops?

LOS ANGELES — As gridlocked Washington edges toward default, states staggering out of the last recession are preparing for the worst: The federal piggy-bank that helps them pay for healthcare, jobless benefits, road building and schools could run out of cash.

Kansas Gov. Sam Brownback is warning that his state might not be able to fully cover potential shortfalls, and jittery California cushioned its finances last week by borrowing $5.4 billion from private investors. Massachusetts is preparing to replace $850 million in U.S. payments that could be derailed in August, while Oregon plans to free up a cache of money if Washington stops sending checks.

Freighted with uncertainty, states can't look to lessons from the past: There aren't any. The U.S. government, which has a gilded credit rating, has never defaulted. And no one seems to know what funding could be cut, by how much or for how long. That would be determined in Washington if Congress fails to raise the government's borrowing limit by Tuesday.

"You're chasing a ghost," says Nevada Department of Health and Human Services Director Mike Willden. "What's the deal? What is the cut? What can I expect?"

A congressional compromise remained elusive, with anxiety over a possible default increasing with the passing days.

At issue is the debt ceiling, a legal limit on how much debt the government can accumulate. If Congress fails to raise the borrowing limit by Tuesday, the U.S. might not be able to pay all its financial obligations. A default could send financial markets and the economy into a tailspin, spreading angst from Wall Street to Main Street.

If the U.S. loses its top-notch credit rating, it could drag down ratings for some states, too, driving up borrowing costs. The most vulnerable are Maryland, Virginia, South Carolina, Tennessee, and New Mexico because of their reliance on federal money, according to one rating agency. A group of California legislators warned Congress that failure to raise the debt limit could threaten a fragile economic recovery — California remains in the grip of double-digit unemployment.

In statehouses around the country, preparations were under way as states judged what would happen if federal dollars slowed or stopped. Some were rushing to claim any federal aid that might be in the pipeline before Tuesday's deadline.

Many states appeared to have enough cash on hand to fill short-term gaps from Washington. For example, Vermont Finance and Management Commissioner Jim Reardon said the state Medicaid program is expected to receive a payment of more than $53 million from the federal government Monday, a day before the federal government might stop paying some bills.

Rhode Island and New Hampshire have enough money on hand to cover expenses through August, giving Congress extra time to resolve the stalemate before programs might take a hit.

But Florida's courts system would be unable to make payroll if a crisis lasts beyond Aug. 22. In North Carolina, state Budget Director Andy Willis said the state could cover Medicaid reimbursements for a few days but floating the payments for a longer period might be a different matter because of a tight budget.

Ohio has an 8.8 percent jobless rate and "if the country stops paying its bills now, those numbers will only get worse," a bipartisan group of Ohio mayors said in a letter to the White House, calling for a settlement.

All states rely on federal aid, but the impact will vary state to state. New Jersey, for example, counts on a smaller percent of federal money for state spending than other states, chiefly because it has more wealthy residents. Kansas gets about half its money from Washington. California, the nation's most populous state, gets nearly $80 billion annually, much of it for health care for the poor.

If the debt ceiling is not lifted by the deadline, the Treasury Department, which issues tens of millions of payments each month for everything from food stamps to Social Security, would have to decide what bills it could pay, in what order. The amount of cash would be limited, since the government borrows about 40 cents of every dollar it spends.

With the fall school term approaching, the University of California is trying to figure out what a U.S. default would mean for more than $3.5 billion in federal research dollars and student aid it's slated to get this year — 720,000 students receive Pell Grants at UC, one of the nation's largest public universities.

In Alabama, the state is moving some of its investment funds into cash to guard against fluctuations in the financial markets. Massachusetts is looking at whether it could provide interim financing to keep some or all of the programs funded, should federal checks slow or stop. The state receives about $200 million a week in federal funds, and 1.25 million people rely on federally subsidized Medicaid.

"If we were to say we can't make those payments any more ... it's hard to imagine what would happen," said Administration and Finance Secretary Jay Gonzalez. "There would be potentially some dire consequences."

Some government officials worry about longer-term damage.

In Los Angeles, the nation's second-largest city, pension funds rely on income from the stock market, and if it plunges taxpayers are on the hook to make up shortfalls that, in a worst-case scenario, could reach hundreds of millions of dollars.

If the region's double-digit unemployment rate goes up, that inevitably digs into the city's share of sales, hotel and other taxes needed to run local government. And if the nation's credit rating goes down, uncertainty could rattle the bond market, making investors less likely to jump in while driving up interest rates that make borrowing more costly for governments around the U.S.

"Should there be a crisis generated by the debt ceiling not being lifted, that would bring us to a very critical state," said City Administrative Officer Miguel Santana.

"We have little room left to manage it. Now we are at the bone in terms of the core services we provide," Santana said. "We are sort of victims to the outcome of the gridlock."

At the Hollywood Senior Center in Portland, Ore., optimism was holding up among the low-income seniors who rely on Medicaid and other social-assistance programs to survive. But executive director Amber Kern-Johnson said the idea of federal dollars drying up seemed unfathomable to the center's clients.

"Many of them just don't believe something like that could happen," Kern-Johnson said.